## What Is the Fisher Effect?

♪ [music] ♪ – [Narrator] What is

the Fisher effect? The Fisher effect describes

the relationship between the inflation rate

and the nominal interest rate. Suppose your grandma lends you $100

at an interest rate of 10%. That’s right, this grandma

has an interest rate. But suppose also that over the year

the inflation rate is 10%. So at the end of the year,

you pay your grandma back $110. That looks pretty good on paper,

but during that year, money has become less valuable. Due to inflation,

what used to cost $100 now costs $110. So what’s your grandma’s

real return? Zero. More generally, we can write

that the real interest rate is equal to the nominal rate,

the rate charged on paper, minus the inflation rate. Inflation reduces

the real return on a loan. So if grandma expected

the inflation rate to be 10%, then in order to get a real return

of 5%, she must charge you a nominal interest rate of 15%. Now you make think Grandma’s cold

for charging you a 15% interest rate, but she isn’t alone

in this behavior. Everyone does it,

and it’s called the Fisher effect, named after the great American

economist Irving Fisher. The Fisher effect observes

that nominal interest rates will rise with expected

inflation rates. We can see the Fisher effect

in this data from the United States. Notice for example how

interest rates and inflation rates were low in the 1960s,

but as inflation increased so did interest rates. Interest rates reached a peak

of almost 20% when inflation hit 15% per year. Since that time,

inflation has fallen, and so have interest rates. So to recap, the Fisher effect

describes how interest rates and expected inflation rates

move in tandem. To learn more about

what causes inflation, click here. Or, to test your knowledge

on the Fisher effect, click here. ♪ [music] ♪ Still here? Check out Marginal Revolution

University’s other popular videos.

Your Grandma is a cold blooded SOB. Get that money, granny.

Do a video on effect of bank repo rate on banks commercial lending rate

Is that Colonel Sanders?

Irving Fisher is a former economist.

Good content on FE 👍

Named the background music?

Thanks

DAMN GRANDMA. A SAVAGE CUH

Thanks alot 🙂